Time - Man of the Year/Time_Man_of_the_Year_Compact_Publishing_3YX-Disc-1_Compact_Publishing_1993.iso/moy/051892/0518200.000

Text File | 1992-09-10 | 10KB | 200 lines

                                                                                BUSINESS, Page 60

The Bankruptcy Game


All sorts of companies are taking refuge in Chapter 11. But too
many use the law to stiff creditors, enrich lawyers and protect
bad managers.

By JOHN GREENWALD -- Reported by Bernard Baumohl/New York, Julie
Johnson/Washington and William McWhirter/Detroit


    According to the American capitalist gospel, it is no sin
to go belly up. Quite to the contrary, U.S. firms enjoy the
most liberal bankruptcy laws on earth -- a privilege
strengthened by a provision of the code known as Chapter 11 that
holds creditors at bay while often allowing sick firms to bleed
new buckets of red ink and still operate for years.

    Congress added the Chapter 11 provision to the federal
bankruptcy code in 1978 so companies could stay in business
while working out repayment plans. But a national debate has now
sprung up over whether the country would be better off if sick
firms were allowed to die. Last year nearly 21,000 firms filed
Chapter 11 petitions, the most since 1986. More signifi cant,
many of the new cases are mammoth, involving such familiar
names as Macy's, TWA and Orion Pictures. While few large
companies entered Chapter 11 before the mid-1980s, more than a
dozen with assets exceeding $5 billion have taken refuge there
in the past three years.

    A growing body of critics charge that Chapter 11 has
become a tool that wily managers can now use to stiff creditors
and preserve their own jobs. Moreover, they argue, companies in
Chapter 11 can take advantage of the fact that they pay no
interest on part of their debt by slashing prices and wreaking
havoc on their competitors. Most companies that take refuge in
Chapter 11 ultimately fail anyway, critics say, leaving
creditors with even fewer assets than if the firms had been
liquidated in the first place. Says Sam Zell, a Chicago
financier: "It isn't good for the economy to prop up cripples
and hand them unfair advantages that allow them to bleed income
and help destroy the healthy competition."

    Horror stories are easy to find. Eastern Airlines had a
net worth of more than $1 billion when it entered Chapter 11 in
1989. But there was little left for creditors by the time
Eastern exhausted $400 million trying to remain aloft before it
quit flying last year. Manville Corp. filed a 1982 petition
solely to escape $2 billion of liability suits brought by
defendants who claimed to have been harmed by the firm's
asbestos products. The next year Frank Lorenzo steered
Continental Airlines into bankruptcy, allegedly to break union
contracts. But the tactic could not save Continental -- now
minus Lorenzo -- from returning to Chapter 11 in 1990.

    Alarmed by such abuses, Congress is considering reforms.
The Senate Judiciary Committee has called for a blue-ribbon
panel to study whether the entire 1,568-page bankruptcy code
should be overhauled. The panel would also consider speedy
alternatives to Chapter 11 proceedings, which last about two
years on average and force companies to expend vast sums of
scarce cash on legal and accounting fees.

    Many experts agree that changes in Chapter 11 are sorely
needed. "Nobody thought it would ever come to this," says Sam
Giordano, executive director of the American Bankruptcy
Institute, a clearinghouse for bankruptcy information. "The law
was meant to keep people employed and allow companies to be good
corporate citizens, not allow bankruptcy to be a shield for
purposes for which it was never intended. Right now," Giordano
says, Chapter 11 "is just a hodgepodge that's being decided on
a case-by-case basis. It's probably time to revisit the law
itself."

    A recent Yale Law Journal article called for junking
Chapter 11 altogether and letting sick companies die. The
authors studied 326 publicly traded firms that had filed
bankruptcy petitions between 1964 and 1989 and found that only
20% had managed to emerge successfully. At the same time, the
article said, bondholders lost 67% more of their investments on
average when companies failed in Chapter 11 than under previous
law. "If stock- and bondholders were worse off, what in the hell
was going on here?" demands co-author Michael Bradley, a law and
finance professor at the University of Michigan. "If the purpose
of Chapter 11 was to protect corporate assets and shareholders,
we found just the opposite."

    Like any hotly contested issue, Chapter 11 has its share
of champions. "On balance, Chapter 11 has been positive for the
economy," says Edward Altman, a finance professor at New York
University's Stern School of Business. "It conserves the assets
and values of firms that have temporary problems but can be
rehabilitated." Altman and doctoral student Edith Hotchkiss
conducted a study that found that at least half the 1,096 firms
entering Chapter 11 between 1979 and 1991 emerged successfully
and have managed to stay out. That study focused exclusively on
publicly held companies in Chapter 11.

    Yet few experts dispute that Chapter 11 cases can run up
huge -- and often excessive -- legal and professional fees,
especially when big companies are involved. LTV Corp., a steel
and aerospace conglomerate, which had sales of $6 billion last
year, has forked out more than $100 million in legal fees since
it entered Chapter 11 in 1986 yet remains mired in debt. As the
megacase grinds on, LTV's bills are piling up at the astonishing
rate of $2.5 million a month.

    But owners and managers of companies in Chapter 11 can do
very well for themselves, thank you, even as creditors take a
beating. William Farley put his $3 billion empire, which
includes Fruit-of-the-Loom apparel, into Chapter 11 last year.
But analysts say Farley could keep as much as $100 million of
his personal fortune and homes in Chicago, Aspen and Maine. In
Washington, real estate developer Dominic Antonelli Jr. has
reached agreement with his creditors in a $700 million Chapter
11 case that would allow him to keep, among other things, $1.9
million in cash along with stock, cars and possessions valued
at $2.1 million. If the deal goes through, the creditors could
get as little as 17 cents on the dollar.

    Inside ailing companies, Chapter 11 filings can lower
morale and strain already tense relations between bosses and
employees. Some TWA workers question owner Carl Icahn's motives
for placing the airline in Chapter 11 in January. Instead of
striving to clean up the company's finances, they say, Icahn's
real goal may be to use Chapter 11 as a shelter from which to
conduct fare wars like his current battle with American
Airlines. "Chapter 11 can be a good opportunity for a company
to cleanse itself of past mistakes," says Bill Compton, chairman
of the pilots' union local at TWA. "But how do you do that when
you have the same managers and employees who created the
problems in the first place?"

    Federated Department Stores emerged from two years of
Chapter 11 proceedings in February after new managers shed $5
billion of the $8.2 billion of debt that previous owner Robert
Campeau had accumulated. Federated -- the parent of
Bloomingdale's, Rich's, Burdines and other chains -- spent much
of the Chapter 11 period reorganizing its finances and closing
weak stores. Macy's also got a new-management look last month
when chairman Edward Finkelstein resigned after filing Chapter
11 papers in January. Finkelstein had come under increasing fire
since using debt to achieve a $3.7 billion buyout of Macy's in
1986 and another $1.1 billion to acquire Bullock's and I. Magnin
stores.

    Some firms have found that the best way to survive Chapter
11 is to escape it as swiftly as possible. The Days Inns motel
chain brought 1,200 franchises out of Chapter 11 in January
after a relatively brief 17-month stay. "A lot of bankruptcies
just go on forever," says John Snodgrass, who heads the
franchise operations. "But the judge made sure we didn't get
bogged down and drawn out. It really serves no one but attorneys
to continue in bankruptcy for a lengthy period of time. It can't
be healthy for a business to do that."

    This commonsense approach is already working for small
North Carolina companies. Under a fast track that U.S.
bankruptcy Judge A. Thomas Small installed in 1987, firms file
their reorganization plans within 90 days and average just six
months in court. Spector Molding, a $3 million plastics company,
made an even quicker getaway; it was in and out of Small's court
in less than two months. "Cases like this are why the code was
written," says Trawick Stubbs, the firm's attorney. "Congress
has said, and I agree, that it's preferable to have
reorganization and rehabilitation rather than liquidation."

    Experts say big firms should speed through Chapter 11 in
the same no-nonsense way. Chicago investor Zell would give
companies an "absolute deadline" of one year to reorganize or
go out of business. ``By having little discipline, you create
a huge playing field for a lot of ghouls to make a living," he
says. "They're all feeding at the trough." For all the richness
of his metaphors, Zell has a point. Tight deadlines could curb
Chapter 11 abuses by encouraging companies to get out of court
quickly and return to the business of surviving in the
marketplace without life support. Or, if that's impossible, to
close up shop and allow their creditors to split the remaining
assets.